You should always bear in mind that entropy is not on your side. Elon Musk
Whether it is politicians whose careers always end in failure, ancient civilisations, unadaptable life forms, great empires, monetary systems, or that ‘nice looking bistro’ recently opened on the High Street, life depends on strategies to beat the fade.
Dowgate Cape Wrath fund manager Adam Rackley and I recently had a conversation with global growth companies’ investment analyst, Alex Sweet. Alex is all about beating the fade, sharing with Adam an interest in ultra running. Alex’s current obsession is a particularly entropic last man standing variant of this crazy sport, called Backyard Ultra. The ultimate beat the fade challenge where, later this year, he is attempting to run three hundred miles in three days.
When running Alex faces the obvious fade of physical exhaustion, muscle fatigue and mental endurance. However, it gives him plenty of time to consider his other obsession, those special companies that can beat the fade; the Sweet Stocks covered in his newsletter. As he puts it:
Economics 101 tells us that supernormal profits are rare and anomalous. The normal forces of competition and ingenuity in the free market mean that any company posting supernormal profits can expect to come under waves of attack. The normal expected outcome from that is a reversion to the mean.
However, Sweet believes there exists a small subset of companies globally, which following the legendary investor Nick Sleep’s hypothesis, can withstand (or even thrive under) the normal onslaught of competitive pressures that prove terminal for most. Sleep’s Nomad Investment partnership enjoyed exceptional returns in the early to mid-2000s with a highly concentrated portfolio of such businesses. Over subsequent years Nomad’s investor letters have become the stuff of legend.
Sleep’s point is that if you can identify these rare beasts, the opportunity derives from the market’s tendency to systematically under value them. As he puts it:
Investors know that, in time, average companies fail, and so stocks are discounted for that risk. However, the discount is applied to all stocks, even those that, in the end, do not fail. The shares of great companies can, therefore, be cheap, in some cases, for decades.
Alex’s approach to finding quality compounders rests on the simple premise that leopards don’t change their spots and therefore he says:
The first place I’ll look is the list of companies that have had a successful run of growth over the last five, ten, fifteen, twenty years. Those companies suggest that they might have something special about them that puts them on this trajectory to continue to post attractive growth.
That sounds simple enough. However, it is then that the hard work of fundamental analysis begins. This is what Nick Sleep describes as understanding a company’s deep reality. What is the essence of the company’s resilience or, to coin a Talebism, its anti-fragility.
Alex does a deep dive into the business reality of his companies understanding their history, the motivations of the founders its senior management and their decision making time frames. Importantly he looks at marrying the businesses’ competitive strengths with the financial returns and capital allocation decisions taken over at least a decade, often longer.
Understanding the deep reality of a company in this manner builds confidence in its ultimate destination. It permits the investor to buy with confidence and then let time and patience do the work.
Sleep’s super moats of competitive strength unearthed through his deep reality checks included Amazon’s ability to allocate capital into new revenue models such as cloud computing and Prime while sharing its huge scale economies with its cost conscious customers in the form of lower prices. Understanding deep reality requires highly disciplined analysis and when successful results in extremely low levels of investing activity.
Sleep said in one of his letters:
We are inactive. Inactive except, perhaps, for the observation, seldom made, that the decision not to do something is still an active decision; it is just that the accountants don’t capture it. We have, broadly, the businesses we want in Nomad and see little advantage to fiddling.
As Sweet sees it, the justification for this approach is:
As the years pass, ultimately, the main determinants of the stock price and the total return will be the company’s earnings, free cash flow, and any dividends and payouts. Over a longer run of years, the most important determinant of the total return will be the growth or otherwise of that company’s earnings.
Growth investing is often, but lazily, described as the antithesis of value investing. However, this misses the point that growth (the output of resilience and adaptability) is just another determinant of value. While deep value investing involves investigating any asset that falls far enough, growth investors of the Sweet and Sleep mould aren’t attracted to this bottom layer of sediment deposited by Mr Market. For them, the allure is quality of the compounding engine, and these are seldom found on the scrap heap. They are the Amazon’s of tomorrow, the outliers lurking in the pack of normality.
Alex reckons he starts with about 6,000 listed stocks globally in his pursuit of a few dozen compounders. He just needs to remove the unsweet stocks from that universe of normal companies. It is alleged that when the pope asked Michelangelo how he carved the statue of David, he answered, I just remove everything that was not David. Simple, but not easy.
Written by Jeremy McKeown
Jackson’s Chart: YOU GOV Monthly (An Analysis by Jackson Wray)
Explanation
YOUGOV (Monthly) – The share price of YouGov has been on an incredible journey over the past 10 years, from a low of c£1 in 2014 to a high of £15.70 in January 2022, gaining over 1100% during the 8 year period, followed by an c70% decline to now. Although this move on the wider view seems to be almost vertical, there was a number of key areas created which are now becoming of importance once again. From the high in 2022, price fell aggressively through the £10.30 support, before being rangebound between here and £8.20, levels which were formed during the pre high move. During the difficult autumn 2023 period for UK SMids, price fell and confirmed support at £6.50 very briefly, before moving strongly higher, forming what we now know as a new higher low (B). A profit warning in June 24 drove price through two converging support levels (red zone highlighted) to complete the D extension of the ABCD formation at c£4. This is also the location of the most significant areas last seen in 2018 & 2020 and will remain an incredibly strong wall of buyers. What now? Probability is with a retest of the £6.50 level, whilst a deeper retracement higher to £8.20 cannot be ruled out in the medium term. This can all occur in the descending structure of this monthly view, but following such a decline and with price at such a key level a move to the next downside support is less probable from a technical standpoint.
Further Reading & Listening:
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